Interest Rate Hike Imminent... Warning on Excessive Leverage (Comprehensive)

Possibility of Interest Rate Hike This Month Gains Weight
Increased Burden for Many Variable Rate Borrowers

[Asia Economy Reporter Park Sun-mi] As the possibility of the Bank of Korea raising the base interest rate in August increases, awareness is growing about the need for debt management, especially among investors who entered the financial market with excessive leverage and borrowers of short-term unsecured loans. Although market interest rates have recently risen rapidly in anticipation of the base rate hike, the growth rate of household loans has not yet slowed, leaving open the possibility that financial authorities may tighten household debt regulations more strongly.

According to Bank of Korea statistics on the 9th, unsecured loans from domestic financial institutions increased by 15.2% last year, mainly at banks, marking the highest growth rate since 2010. Among these, the proportion of variable-rate unsecured loans rose to 77.7% as of the end of March this year. By remaining maturity, 41.9% are under 6 months, 42.5% between 6 months and 1 year, 8.3% between 1 and 3 years, and 7.4% over 3 years, indicating a concentration in short-term loans. This means that with the significant increase in bank unsecured loans, there are more borrowers with variable-rate loans and short maturities.

When interest rate normalization begins, borrowers with a high proportion of variable-rate loans and short maturities will inevitably be hit the hardest. The Korea Institute of Finance predicted in its report "Financial Consumer Response to Interest Rate Normalization" that borrowers of variable-rate unsecured loans with short maturities will be relatively more affected than mortgage borrowers when interest rate normalization starts.

Variable-rate (loan base rate + spread) products periodically adjust the loan base rate to reflect market fluctuations. Unsecured loans use bank bond rates as the loan base rate, while mortgage loans use the COFIX rate.

While bank bond rates respond sensitively to market conditions, COFIX rates also depend on deposit interest rates influenced by banks’ business strategies such as the need to attract deposits. Therefore, during periods of rising interest rates, unsecured loan rates are likely to increase faster. In fact, according to the Korea Federation of Banks, the average spread on general unsecured loans at the five major commercial banks?KB Kookmin, Shinhan, Woori, Hana, and NH Nonghyup?has risen by up to 0.3 percentage points compared to the beginning of the year, reflecting a rapid increase trend.

Possibility of Further Tightening Household Loans ↑

Despite strengthened household loan management by financial authorities, the outstanding household loans at commercial banks are rapidly increasing. At the end of last month, the outstanding household loans at the five major commercial banks totaled 695.3081 trillion won, an increase of 6.2009 trillion won compared to the end of June. Although the outstanding household loans decreased by 3.0546 trillion won in May compared to the previous month, the increase expanded for two consecutive months in June (1.2996 trillion won) and July (6.2009 trillion won). This has led to criticism that the application of a 40% Debt Service Ratio (DSR) for all borrowers, which started in July, has yet to show its effect.

In particular, the outstanding personal unsecured loans at the five major banks reached 140.8931 trillion won at the end of July, increasing by 18.637 trillion won in one month, more than three times the increase in June. This is due to more young people leveraging loans for investment amid expectations of rising financial and real estate asset prices despite the spread of COVID-19.

In the stock market, the proportion of new investors who started investing in stocks for the first time surged from 9.3% in 2019 to 32.8% in 2020. More than half of these are young people aged 30 or younger. High-credit borrowers’ unsecured loans also increased noticeably in regions where housing prices rose sharply in 2020.

As household loans increase, the financial authorities, which set the household debt growth target at 5-6% this year, are expected to face considerable pressure in policy management. Since the household debt growth rate in the first half of the year was 8-9%, the growth rate must be managed at 3-4% in the second half to achieve the annual target.

Lim Hyung-seok, a research fellow at the Korea Institute of Finance, advised, "Consumers who relied on low interest rates to pursue excessive leverage should now focus on debt management due to investment risk management and increased interest burdens," adding, "Facing interest rate normalization, it is time to establish rational investment practices based on economic fundamentals within the scope of debt repayment ability."

This content was produced with the assistance of AI translation services.